As consumer spending slowed significantly in December and January, the market value of many retail stocks plummeted. Shares of Jo-Ann Stores were not immune.  They entered 2008 at $13.08 and fell to a multi-year low of $9.03 on January 16th after trading as high as $34 in June 2007. As we watched the shares fall below $10 we asked ourselves - was anybody looking at its income statement or balance sheet? We knew Jo-Ann Stores had a tangible book value of over $17 and sales of over $70 a share. With EBIT margins historically in the 5-6% range, its earnings per share could once again reach over $2.00 a share given a bit of sales growth. Our hunch was that investors were indiscriminately selling based on their macro-economic view of a slowing economy without doing much research on the company itself.

Nevertheless, we decided to revisit our investment thesis and reexamine our fundamental analysis. While many retailers were, in fact, facing slower store traffic, we felt Jo-Ann Stores would probably fare better than most companies. First of all, arts and craft stores tend to hold up better during a slowing economy. The average ticket at Jo-Ann Stores is only $20, and most of their customers earn higher incomes which means they are not as affected by rising oil and food costs.  Second, we knew the competitive environment was improving. Jo-Ann’s largest competitor, Hancock Fabrics, had been closing stores and Wal-Mart was exiting the category at many of its locations.  Finally, management had made great efforts during the last 18 months to improve the shopping experience for its customers. Better signage, wider aisles and improved merchandise selection we felt would lead to increased purchases and a higher frequency of visits.  In the end, we felt comfortable with our analysis and decided to stick with our Jo-Ann investment. We were patient and would await a positive catalyst. Fortunately, good news was not long in coming.

On Feb 7th, Jo-Ann stores announced that its same store sales rose 3.3% in the fourth quarter that ended on January 31st 2008. This was impressive given the very difficult retail environment and the fact that sales at Wal-Mart, an important comparable, were up only 0.5%. Investors reacted positively to the news. Shares of Jo-Ann Stores have risen by 25% since the news and have rallied 78% from their January low of $9.03 to $16.14. More importantly however, we believe this story highlights the significant opportunities that are present in our ABC portfolios.  In our opinion, many of our holdings, due to the recent panic in the markets, have been taken down too low relative to their intrinsic and/or net asset values.  Fortunately, as these fundamentally undervalued companies report positive financial results such as improving sales, better margins etc, they are likely to be rediscovered by inquisitive investors.

March 20, 2008

On March 12th Jo-Ann Stores reported financial results for the fourth quarter and full year. Net earnings for the quarter were $27.5 million, or $1.10 per share compared with earnings of $25.8 million or $1.05 per share in the prior year. Net earnings for the full fiscal year ending February 2nd, were $15.4 million, or $0.62 per share compared with a loss of $1.9 million or $0.08 per share last year. It should be noted that these results were above the company’s initial guidance of between $0.55 and $0.60 per share.

Net sales for the fourth quarter decreased 2.5% to $585.9 million compared to the same period last year. However, on a comparable 13-week basis, fourth quarter same-store sales increased 3.3% versus a same-store sales decrease of 6.0% in last year’s fourth quarter. Given the difficult economic environment, we believe these strong results are a testament to the company’s remerchandising strategy, an improving competitive environment, and the relatively recession proof characteristics of the fabrics and crafts business.

For fiscal 2009, Jo-Ann Stores expects earnings to improve to between $0.70 and $0.85 per share. This guidance assumes same stores sales growth of between 1% and 3%, an increase in gross margin, and SG&A expense leverage. Investors should keep in mind, however, that for the past two quarters, management’s guidance has proved to be too conservative. While the market may not appreciate the cautious nature of this executive team, we believe investors will eventually be rewarded as Jo-Ann Stores continues to deliver balanced and consistent improvements to its operations and financial results.

Despite continuing fears of a US recession due to rising gasoline prices, falling home values and volatile stock market conditions, Jo-Ann Stores continues to perform well.  On May 8th the Company announced that sales for the first quarter ended May 3rd increased 5.2% to $446.1 million from $424.2 million in the prior year. In addition, same store sales increased by 4.5% which was above management’s guidance of between 1% to 3%. In fact, given these strong first quarter sales results, expected annual earnings of between $0.70 and $0.85 per share will probably prove to be too conservative.  Incidentally, Wall Street seems to have taken notice of management’s under-promise and over-deliver approach. At its recent price of around $22, shares of Jo-Ann Stores have risen 18% this month and are up 58% so far this year.

As you many recall, retailing stocks plummeted in January over mounting economic and credit fears. Jo-Ann Stores was not immune. The shares, which peaked around $34 in May 2007, eventually fell to a multi-year low of $9.03 on January 16th.  As holders of 1,225,000 shares, or almost 4.85% of the company, we were left scratching our heads. In our opinion, Jo-Ann Stores looked extremely undervalued. The company had a tangible book value per share of over $17.25 and earnings power of over $2 a share assuming margins returned to normalized levels. While many retailers would be hurt by an economic slowdown, we felt Jo-Ann would probably fare better than most companies. This is due to the recession-proof nature of arts and crafts products, an improving competitive environment and a better merchandise assortment of basic every day non-seasonal items.

While we were eventually proven right on our Jo-Ann Stores thesis, we feel the dramatic fall and subsequent rise in its shares illustrates a number of valuable lessons. Firstly, in order to earn above average investment returns one must often hold a view that is divergent from the market. Secondly, successful investing requires a large amount of patience, the courage of one’s convictions, but most importantly a strong stomach. Thirdly, we believe the Jo-Ann story is characteristic of the significant opportunities that are present in our ABC portfolios. In our opinion, many of our holdings, due to the recent extraordinary volatility in the markets, have been sold down too low relative to their intrinsic and/or net asset values.  Fortunately, as these fundamentally undervalued companies report positive financial results such as improving sales, better margins etc, they are likely to be rediscovered by inquisitive investors.

On a final note, spring is traditionally the season when companies mail investors their annual reports.  In addition to providing financial statements, an annual report will typically include a “letter to shareholders” as well. An investor can glean a lot of valuable information from this letter such as the company’s long term strategy, what new trends management has identified and what capital investments will be made in the coming year. Incidentally an experienced portfolio manager will also know how to read between the lines to determine, for example, whether management is telling the whole story and, if not, what is being left out.  We feel Jo-Ann Stores is a good example of a company that communicates well with its shareholders.  Interestingly, for this year’s annual report the company produced its first Online Video Annual Report.  We thought you might enjoy watching it as we found it quite useful and insightful. We have posted a link to the video below.

http://icr.vo.llnwd.net/o1/IDM_Hosting/VAR/JAS/JAS_VAR_08_prn.html

June 6, 2008

On May 28th, 2008, Jo-Ann Stores announced first quarter results for the period ended May 3rd. Net sales increased by 5.2% to $446.1 million while same-store sales increased an impressive 4.5%. Earnings for the quarter were $3.0 million or $0.12 per share compared to a net loss of $1.7 million or $0.07 loss per share last year. Analysts who cover the stock had expected Jo-Ann Stores to earn just $0.01 per share. According to Jo-Ann Stores’ CEO Darren Webb, “This was our fifth consecutive quarter of same-store sales improvement and seventh consecutive quarter of increasing earnings per share. The current economic environment remains uncertain, but we will continue to focus on executing our strategic initiatives and enhancing our competitive position to deliver balanced and consistent performance throughout fiscal 2009 and beyond”.

Based on these encouraging first quarter results, management has revised its earnings outlook for the full year from between $0.70 to $0.85 per share to between $0.75 and $0.85 per share. It should be noted that this guidance assumes same store sales growth for the year of between 1% and 3%. However, given that same stores sales are currently trending above this level, management’s guidance could once again prove to be too conservative.  In fact, many brokerage firms have recently increased their estimates for the year to $0.93 per share – above management’s given target range.

Jo-Ann Store’s consistent positive results has not gone unnoticed by investors. Despite the slowing US economy, shares of Jo-Ann Stores have rallied 77% year to date and are up 255% from its January 16th low of $9.03. However, at just 1.25 times its tangible book value of $17.96, the shares are clearly not expensive relative to its peers. We would note that for specialty retail stocks in the US, the mean price to book value ratio is currently 1.8 times or roughly 50% higher than Jo-Ann Stores’. We believe this valuation gap could continue to narrow if same store sales remain positive and earnings continue to exceed management and analyst’s estimates. As a side point, bear in mind that Jo-Ann Stores has no controlling shareholder and, as a result, could be the subject of a takeover rumour. This is exactly what happened last June when Jo-Ann’s share price spiked to a peak of $34.74.

Finally, for those who missed our last write up, we would encourage you to watch the company’s recently released annual video report. We found it quite useful and insightful. We have posted a link to the video below.

http://icr.vo.llnwd.net/o1/IDM_Hosting/VAR/JAS/JAS_VAR_08_prn.html

January 16, 2009

Shares of Jo-Ann Stores have been on a wild ride over the past twelve months.  From a low of approximately $9 in early 2008, the stock tripled to a high of $27 in September and then pulled back to almost $10 in November.  They have since recovered somewhat and closed at $13.45 yesterday.  Given that Jo-Ann Stores is generally thought to be more “recession-proof” than other discretionary retailers, the share price volatility is astounding.

Fundamental data was released on December 3, 2008, when the Company reported operating and financial results for the period ended November 1.  Unfortunately, after posting same store sales growth in the first two quarters of the year, this key indicator deteriorated in the third quarter.  Although sales were essentially flat at $480 million, same store sales decreased 1.5% on a year over year basis.  However, on a nine-month basis, same store sales remained positive, increasing 1.9% over the comparable period in 2007.  Based on management’s assumptions for the balance of fiscal 2009, same store sales are expected to be flat compared to the previously announced range of 2.0 to 3.5% growth.

Despite the decline in same store sales, several positive trends were apparent in the financial results.  The Company’s gross margin improved by approximately 100 basis points to 49%, due to reduced discounting and cost savings from better inventory sourcing.  Moving to the bottom of the income statement, net income for the quarter was $10.2 million, or $0.40 per diluted share, compared net come of $8.0 million, or $0.32 per diluted share, last year.  Even excluding an unusual gain of $0.05 per share in the current quarter, EPS still grew almost 10% year over year.  The $0.05 gain was related to the repurchase of a portion of the Company’s Senior Subordinated Notes.  Management astutely bought $20.4 million of the notes at a discount of approximately 12% to par value.  Since last year, the Company’s long-term debt has declined to $112.7 million compared to $202.0 million.  Finally, we were quite pleased to see solid inventory management, with a reduction to $522.0 million from $570.3 million a year ago.  Freeing up working capital generates cash, which is king in the current environment.

July 24, 2009

After a remarkable rebound from a 52-week low of $10.31, Jo-Ann Stores currently trades above $22 per share.  We were not surprised by this recovery, since we believed that the Company should perform better than more economically sensitive retailers.  Even in recessions, people are willing to make small expenditures on hobbies and crafts as a little “pick-me-up”.  In fact, same-store sales grew 0.5% in fiscal 2009 and 1.0% in the first quarter of fiscal 2010.

Further, management has been doing a great job on controlling costs and generating other operating synergies.  They have also been making the right strategic decisions in the capital markets, such as buying back senior subordinated notes at an average discount of approximately 9% to par value.  In the second quarter earnings release, management affirmed previous guidance for earnings in the range of $0.70 to $0.85 per share despite same-store sales declines of between 2% and 4%.  We believe that management may be low-balling this number and the current consensus estimate for fiscal 2010 is approximately $1.00 per share.

However, given the dramatic share price move, we have decided to liquidate our entire position in Jo-Anne Stores.  At approximately 25 times trailing and over 20 times forward earnings, we believe that much of the recovery has been priced into the stock.  Because we are seeing more attractive opportunities on a risk/reward basis, we decided to sell our position on strength.